Thursday's Bank of England policy meeting is expected to create volatility for the pound due to uncertainty as markets do not expect a rate hike, but the Bank could still deliver a “hawkish” surprise. The IMF has said that the time to hike is now but any justification for a rate hike delay would be attributed to the emergence of the Omicron variant and further government restrictions to control its spread.

Market expectations

The market now expects the Bank rate to remain the same at 0.10%. Any surprises from the Bank or solid guidance to quickly push interest rates higher once the Omicron wave has passed in 2022 could push the pound higher. Bank of America and other analysts expect the Bank to keep rates unchanged and signal an interest rate rise in February.

While analysts believe that under other circumstances the Bank of England (BoE) would have hiked rates, the Bank still needs to wait and see as the current uncertainty brought by the Omicron variant could have serious repercussions on the economy with possibly more restrictions coming in the weeks ahead. According to insiders, the furlough scheme which ended in September could be brought back if new restrictions are put in place because of Omicron.

While a small hike could be possible, the foreign exchange market is now expecting rates to be left unchanged. Fading expectations for a rate hike this December were responsible for the weakness in the pound in recent weeks.

The pound and uncertainty about an interest rate hike

For many analysts, there is still much uncertainty about the Bank’s impending decision. If the market has some lingering expectation for a rate hike, then keeping interest rates the same could weaken the pound.

According to Bank of America, there are a number of factors that could hurt the pound as we move into 2022. A rate hike will clearly support the pound, and there are still analysts who believe this scenario. They believe that by Thursday (16 December), the Bank will have sufficient information for a 15bp hike, such as tight labour market conditions. Data from the ONS has shown that the end of the furlough scheme has not resulted in a spike of unemployment and many people on furlough returned to their jobs. The recent news of low unemployment, robust wage growth and increased number of vacancies provide a clear picture of a strong labour market. But some members of the MPC could highlight that the number of jobs and hours worked is still below pre-pandemic levels.

In their assessment of the UK economy, the IMF said that monetary policy needs to withdraw the financial support that was offered during the pandemic in 2020. They expect the Bank rate to remain unchanged, but they believe there will be a clear direction towards raising interest rates rapidly thereafter.

Analysts have noted that the risks for the pound are limited, if an interest rate rise is not announced on the 16th of December. They will be focussing on comments by policymakers and on the meeting’s minutes regarding the reasons for delaying monetary policy tightening.

The pound could gain support if there are strong signals that the Bank will proceed to a number of rate hikes at a later stage, if the costs of the new variant are seen as limited.

While the timing of the first rate hike has now changed and markets expect this to take place in February 2022, analysts at Barclays remain positive and see the pound to appreciate in 2022, supported by the BoE’s tightening, higher inflation and an increased number of inbound mergers and acquisitions.

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The pound was higher against the euro following the release of the latest UK labour market statistics for the period between October and November. However, it remained lower against the dollar as markets have lowered their expectations for an interest rate hike this week.

The data showed that wage growth was stronger than expected, something that suggests inflation will remain higher for longer than the Bank of England had anticipated.

The data has also shown that the end of the government’s job support scheme did not result in higher unemployment, which will further provide the Bank of England with positive news that the UK economy is strong enough to support higher interest rates in the coming year.

The encouraging labour data comes at a time where the UK and the rest of the world is facing widespread concerns about the rise in Covid infections and the spread of the Omicron variant, which might affect the Bank’s decision to raise interest rates any time soon. Markets are now expecting that the Bank’s Monetary Policy meeting on the 16th of December will result in interest rates remaining the same. As Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, pointed out, today’s report “would have been strong enough to convince the MPC to raise Bank Rate at this week’s meeting, if Omicron had not emerged.” However, despite the emergence of Omicron, the economic outlook is positive for the economy and the pound.

Labour market

Unemployment has fallen again as businesses employed more staff after the end of the furlough scheme in September. The unemployment total fell by 127,000 in the August-October period and pushed the UK jobless rate down to 4.2%. The data shows that the market was strong in autumn, but firms were unable to use the Coronavirus Job Retention Scheme to cover temporarily side-lined staff wages.

The Office for National Statistics also reported that an extra 257,000 people were in payrolled employment in November than the previous month. The number of people working rose by 149,000 and reached to 32.5 million.

Vacancies hit a new record high of 1.219 million in September to November 2021. However, vacancy growth has slowed.

Economists are warning that jobs growth may now be coming to a halt due to the Omicron variant. According to global job site Indeed, “job posting growth may be stalling. As of last Friday, 10th December, postings on Indeed were still 47.3% higher than before the pandemic - but that’s a decline of 0.3% compared to the previous week, on a seasonally adjusted basis. As the Omicron variant takes hold and MPs vote on a new set of Covid restrictions, many sectors that have been doing particularly well this year - from hospitality to high street retail - will be deeply worried that their progress could be abruptly halted.”

Plan B threatens economic recovery

The rise in payroll employment and falling unemployment is positive news for the UK economy and the pound. However, economists have highlighted that 1.2m vacancies remain unfilled, and firms are struggling to hire staff.

The effects of Brexit and the coronavirus pandemic are slowly impacting on the labour market as there are staff shortages which could eventually affect economic activity. Plan B restrictions could also damage the labour market’s recovery especially those sectors affected more severely, such as the hospitality and retail sectors.

Bank of England and interest rate rise

Economists believe that if the Bank of England avoids raising interest rates on the 16th of December, then it will definitely have to raise rates in February, an expectation that will push the pound higher.

The fact that the end of the furlough scheme has not resulted in a surge in unemployment is good news for the Bank, however there are persistent issues, and many have called the government to step in and provide support.

The director of the Institute for Employment Studies (IES), Tony Wilson has said that “despite record vacancies and the tightest labour market in our lifetimes, the number of people out of work and not looking for work is rising” and there is currently almost “one million fewer people in the jobs market than there would have been on pre-crisis trends.” Additionally, he said that with the “prospect of tighter Covid restrictions in the new year, the government needs to be planning now for more support to help people get back into work as well as to protect those jobs that may be at risk in a Plan C lockdown.”

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The pound could rise against the euro due to the Bank of England’s optimistic stance as interest rates are now expected to rise earlier than previously anticipated. The pound was also pushed higher as traders looking for a good offer bought a cheaper pound. According to analysts, the pound could reach new highs by the end of this year.

Bank of England and Rate hike

While last week, the pound fell due to inflationary concerns, over the weekend it was higher. With limited economic data the week ahead, the pound will be likely influenced by more news on the fuel crisis, but analysts expect it to remain supported on BoE’s interest rate prospects. The Office for National Statistics has also upgraded its second quarter GDP growth forecast from 4.8% to 5.4%. With the Monetary Policy Committee of the BoE expected to raise the bank rate to 0.25% in May and one more time in 12 months, markets are optimistic.

In a speech that was given to the Society of Professional Economists annual dinner, the Governor of the Bank of England said: “All of us believe that there will need to be some modest tightening of policy to be consistent with meeting the inflation target sustainably over the medium term. Recent evidence appears to have strengthened that case, but there remain substantial uncertainties and we are monitoring the situation closely. The BoE policymakers would need to see clear evidence that the labour market is thriving and employment activity is back to normal levels before taking any action.

Labour market possible scenarios

The BoE governor in his speech, outlined three potential scenarios for the labour market, highlighting the uncertainties ahead, as each of these could influence growth, inflation and monetary policy in different ways. The first scenario revolves around the furlough scheme and how after the furloughed workers return to their old jobs, we are still left with an excess of job vacancies. If these vacancies are linked with shortages of workers in particular sectors, this could push wages higher. This situation could raise the rate of unemployment consistent with stable wage growth. In a second scenario, where demand rises over time, vacancies and unemployment could fall. In the third possible explanation, advertised vacancies could be higher, but some of these could turn out not to be jobs as employers change their mind or postpone hiring.

Tightening monetary policy and bank rate

Governor Bailey has characteristically said that despite uncertainty, the stimulus program will need to unwind, and this will be coupled with an increase in the bank rate. He said: “For most members of the MPC, the outlook for the labour market – as I described earlier – is highly uncertain and to some degree likely to be resolved in fairly short order, and this justified a wait and see approach on policy in view of the continuing belief that higher inflation will be temporary. Within this view, some members put more emphasis on the continuing shortfall in the level of GDP relative to pre-Covid, while others emphasised the continuing direction of travel towards closing that gap and the evidence of cost pressures accompanying the closing. But all of this group were of the view that the stimulus to monetary policy enacted in response to Covid would need to start to unwind at some point, that unwind should be enacted by an increase in Bank Rate, and if appropriate would not need to wait for the end of the current asset purchase programme.”

This means that the Bank is expected to normalise its policy in early 2022 which could support the pound. Analysts view the pound’s recent weakness as temporary and expect it to strengthen in the long-term.

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If strong domestic data confirm expectations that the UK economy is growing, then the pound could rise higher. According to a recent UK business activity survey, the August Bank holiday weekend is expected to push business revenue higher as more consumers flock to the shops.

Sterling will remain volatile due to global developments and concerns about the spread of the new Covid variant, but UK economic growth and Bank of England policy will also be key drivers of the currency. The release of better-than-expected economic data will offer much needed support to the economy and the pound.

Pound sentiment suppressed due to labour market concerns

Concerns that a labour shortage could impact on the UK’s economic recovery have been expressed in the quarterly survey from the Confederation of British Industry (CBI). A quarterly survey conducted by the CBI from July 29 to Aug. 16, showed that optimism was at minus 17% this month, down from May’s 47% as companies struggled to bounce back after the pandemic. Charlotte Dendy principal economist for the CBI, said on Thursday that “Firms in sectors such as hotels, restaurants and travel do not expect this strength to persist into the next quarter, reflecting the pressure that consumer services firms continue to face.” Labour shortages could weigh on businesses’ investment plans for the next 12 months.

For services businesses, there are added costs and higher wages after the pandemic that they need to resolve, while Brexit has made it more difficult to access talent from the EU. An index tracing the outlook for costs showed that it has reached the higher in two years and is starting to filter through to the prices, with average selling prices rising at the fastest rate since 2019.

Bank of England interest rate hike

The Bank of England is expected to raise interest rates in 2022, but analysts say that for the pound to rise higher in a sustained manner it will take an earlier hike, or more than one interest rate rises after 2022. Markets are hopeful that the economy will expand, and the labour market improve in order to see any substantial shift higher in the pound’s performance.

Short-term pound volatility

Federal Reserve Chair Jerome Powell's speech to the Jackson Hole economic conference on Friday will possibly offer few new hints about ending its quantitative easing programme. If it does show any clear indication that it intends to proceed with tapering the $120 billion in monthly purchases of Treasuries and mortgage-backed securities, then this will have a negative impact on global economic growth, but it will be supportive of the Dollar. If the Fed indicates that they are not yet ready to proceed to reduce its massive asset purchases, as the delta variant continues to spread rapidly igniting further fears of an economic slowdown, then the US dollar will fall. As Goldman Sachs economists have said earlier this week, Powell will be cautious not to lock in a specific date for starting the taper and he would keep the possibility for starting in November open.

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